Gray Swans

In April we wrote a market commentary titled the Black Swan. We mused; If stock markets continue to shoot higher maybe this is how investors will explain, with hindsight bias, the obvious reason for this black swan event; when the government put record amounts of stimulus into an economy that was only temporarily impacted, but structurally sound, when the temporary obstruction was removed, of course, the economy was greatly overstimulated. The NASDAQ is currently in record territory and the S&P 500 has turned positive for the year. This is far from the consensus views that have filled our airwaves and inboxes since the beginning of this pandemic.

Covid-19 is still very much a part of daily life. This economic obstruction has not been removed, but facemasks and social distancing have taken the place of lockdowns. As evidenced by many economic indicators, the new normal is starting to resemble the old regular. The old regular is just hard to recognize behind its facemask. When the coronavirus is no longer a part of our daily lives, we may refer to this bounce back as a black swan event. Right now, we've decided to refer to it as a gray swan event. Despite the economy's organic recovery, our Crazy Uncle Fed continues to pump liquidity into the economy at record levels. We consistently advise our investors not to fight Uncle Fed. Mike Tyson is the most feared fighter of all-time and just announced a comeback at age 54. We also advise you not to fight Mike Tyson. If you feel the need to fight one or the other though, choose Mike Tyson. Uncle Fed is a party animal that has much more money than you and will determine the path of financial markets in the near-term. He continues to buy financial assets, sending prices higher.

Uncle Fed continues to put us in a bit of a quandary. We are valuation-based investors that believe asset prices are based on the marginal investor’s view of fair valuation. When the marginal investor believes prices have become too high (low) prices will decrease (increase). That said, we also are not foolish enough to fight the Fed. Until Uncle Fed stops buying assets, we are forced to look beyond our traditional valuation frameworks and follow our crazy uncle. Uncle Fed has brought his crazy friends from Europe and Asia to the party. They are party animals too. The European Central Bank (ECB) and Bank of Japan (BOJ) are also directly buying financial assets on the open market. This continues to push global asset prices higher.

As we continue to speak with each of you on an individual basis, there is universal concern about how much markets have appreciated and the expectation of an eventual collapse. We share both concerns. We expect both stock and bond markets will continue appreciating so long as Central Banks keep purchasing assets and pumping liquidity into the financial system. We also expect markets to materially drop when they stop. We don’t know when this will be. Two of GreenPort's most reliable indicators in our equity framework are now giving opposite signals. Our longer-term momentum indicator quickly picked up on the Federal Reserve's asset purchases and has been signaling a Bull Regime since early April.

This is a very reliable variable that has treated us well. The numbers speak for themselves. During Bull Regimes investors have received higher returns with less volatility. During Bear Regimes investors have received lower returns with double the volatility. The risk/reward ratio is 2.5X higher for stocks during Bull Regimes than Bear Regimes

Here's our concern. Another very reliable indicator within our equity framework is indicating that the stock market is currently mildly overbought in the short-term. The odds of a shorter-term pullback in stock prices have started to increase. Although it's likely we will become more overbought before there is a pullback, we are concerned.

At this time, we believe it is prudent to modestly lower our stock exposure despite our expectations that stocks will continue moving higher over the longer-term. We have lowered equity exposure by 2.0% in our most Conservative Strategy and 5% in our most Aggressive Strategy.

We are reminded of the Wall Street adage regarding bulls, bears, and pigs. Our momentum variable (primary indicator) expects stock markets to continue moving higher but our shorter-term overbought/oversold oscillator (secondary indicator) shows an asymmetric risk of a short-term correction following this historic recovery in stock prices from their March 23rd lows. If stocks continue to move higher we will likely continue to trim our equity exposure. If stocks do materially sell-off in the near term, we will likely add back the equity exposure we are trimming today. Now is also a good time to reflect on your personal risk profile. The severe temporary losses suffered during the pandemic lows have been mostly recovered. It was a stark reminder that perceived risk tolerance is often higher than actual risk tolerance. If you found this year's fluctuation in asset prices to be more difficult than you would have expected, you should consider adjusting your risk profile lower. We will continue reaching out to each of you individually to discuss your financial plan, risk profile, and investment strategy. Despite the rapidly changing world around us, what hasn't changed is this; A well designed financial plan coupled with a disciplined investment strategy continues to be the key to financial success. We miss seeing you in person. Stay safe, wear a mask, and maintain a safe social distance. Our models are forecasting this will allow us to see you sooner as opposed to later. The GreenPort Team